Talk to Trusted Advisors, Make a Plan, and Stick to It

One legacy of the COVID-19 pandemic is an increase in the number of businesses with financial results that cast substantial doubt on whether they will survive one year into the future.

When the numbers indicate a company will not likely meet its cash flow needs for the next 12 months, auditors must include a “going concern” analysis as part of the annual audit, and possibly a “going concern opinion” in the financial statement report.

In the accounting world, a going concern is a company that has the resources to continue operating indefinitely, given its current revenues, expenses and cash flow. So, being a going concern is a good thing, and most companies are presumed to be going concerns unless certain danger signs are present.

Those danger signs include:

  • Negative working capital
  • Negative trends in revenue
  • Negative trends in gross profit margin
  • Negative equity or a retained deficit

Any one of these signs can trigger the need for a going concern analysis.

Don’t Panic

If you find your company subject to a going concern analysis, don’t panic. The auditor will ask you to provide a plan for strengthening your position. For instance, at the height of the pandemic some companies received substantial Paycheck Protection Program loans and other COVID-19-related government relief. Others were able to retool quickly to produce new products that were in demand such as masks and hand sanitizer, creating new revenue streams. These funds can help provide a clear path to financial health.

In these cases, the going concern analysis is usually still performed, but the auditor may determine the corrective measures are enough to avoid inclusion of a going concern opinion in the financial statement. This is important because the financial statement is provided to your lender, and banks sometimes tighten up on lending to companies with going concern opinions.

Make a Plan

If your company is subject to a going concern analysis and opinion, the key corrective measures you can take include:

  • Secure additional lending. This can be tricky with a going concern opinion in your financial statement, but if the bank has a history with you, believes the situation is temporary, and approves of your corrective measures, they will likely be willing to increase a line of credit to protect your longstanding relationship. You can solidify your position with the bank by notifying them in advance that a going concern opinion will be included in your financial statement.
  • Cut expenses. Be prepared to provide your auditor with a detailed list of which expenses you will cut, and how.
  • If your company is a smaller privately held entity, you and other owners may need to loan personal capital to it.
  • Suspend distribution payments to yourself and other owners.

Your auditor will likely ask you to provide a cash flow projection for the next 12 months as part of the corrective plan, including the assumptions underlying the projection. Make sure your assumptions are reasonable and supportable. For instance, if you include additional bank lending as one measure, talk to your banker first, since the auditor will ask the bank to confirm it.

Of course, many business owners, especially those in hard-hit industries like hospitality, can’t be certain about what the next 12 months will look like. The continuing pandemic and low vaccination rates would restrain even the most eternal of optimists. Discuss this with your advisors and come up with a plan that is achievable.

Compounding Factors

The increase in businesses requiring going concern analyses is a nationwide phenomenon brought on, in part, by other factors that are compounding the fallout from COVID-19.

The economic effects of the pandemic continue to wreak havoc in some industries, such as construction and retail, where worldwide supply chain disruptions are halting or slowing down work.

Another compounding factor is a change in auditing standards that took effect about two years ago, which requires auditors who see evidence of a going concern situation to look out a full 12 months from the date of issuance of the financial statement to determine if an organization can meet its cash flow requirements. That’s a tougher standard than the previous rule, which required the auditor to look out 12 months from the date of the balance sheet. It bought companies some time that they no longer have to pull out of the doldrums.

The Good News

It can be stressful to realize your company could be on the brink of failing. You are working hard and so are your employees. You have a lot of people – workers, customers, vendors and your own family depending on you.

But if your auditor tells you a going concern analysis and opinion is on the table, take heart. Most companies in this position pull out of it and return to financial health.

Keep a cool head, work with your trusted advisors, and put together a plan. Then follow it.

If you would like to have a conversation about your company’s position and what you can do to avoid a going concern analysis – or plan to pull out of it if you’re already in that situation – contact your Adams Brown advisor.